Investment markets around the world have been declining sharply this week in response to the Coronavirus outbreak.
Plans, Portfolios, and Uncertainty
By the closing bell of US financial markets on Thursday, February 27, US stocks had entered what is commonly referred to as “correction” territory, with most indexes, including the S&P 500, Dow Jones Industrials, and NASDAQ, declining more than 10% from their all-time highs reached just two weeks ago. Both 10-Year and 30-Year US Treasury Bonds closed at all-time low effective yields as investors sold declining stocks and bought these so-called safe-haven assets. Year to date, intermediate bonds have returned almost 3%.1
At Foster Group we understand that these kinds of market experiences are distressing to investors. We have similar initial reactions. It is very normal to ask what, if anything, should be done. One of our five principles to better investment outcomes states that planning guides portfolio construction. So, our counsel to clients continues to include the reminder that diversified portfolios created in accordance with well thought out, long-term financial plans (or investment policies for institutions), are already prepared to weather market events like this.
Our second principle encourages investors to embrace uncertainty. Why embrace it? Because it is a part of every aspect of our lives, from investing to health to weather to politics. Rather than denying uncertainty, or seeking a kind of certainty that is unavailable, investors are better off responding positively to uncertainty by taking actions to financially prepare for the unpredictable, in this case, a potential global health crisis. Additionally, embracing uncertainty helps us prepare mentally and emotionally for when the improbable occurs.
What do we know about the virus?
The first reported cases of the Coronavirus in humans were diagnosed in China on December 1, 2019. Initially the spread of the virus was largely isolated to the Hubei Province in China, where it now appears to be declining. However, in the last week, small pockets of infections have been diagnosed in other countries, most notably South Korea, Italy, and Iran. The US Centers for Disease Control reported 15 known cases in the US, not counting repatriated Americans from China and cruise ships.
Medical experts have been working to understand the nature of this new virus. Genetic researchers had mapped the virus by January 10th, only a month after the first related case of pneumonia was diagnosed in China. Since then various government health agencies, biotech and pharmaceutical companies have been working on better diagnosis tools, as well as potential treatments and vaccines.
While the Coronavirus is a threat, modern medical science gives us reason for optimism that it will ultimately be controlled.
What do we know about financial markets?
Investors generally respond negatively to uncertainty leading investment markets to decline. Currently no one knows the extent to which the Coronavirus will affect public health and economic activity. This week, several companies including Apple, the largest US company, have released guidance saying that due to the virus, expected revenues for at least the first quarter will be negatively impacted. It is very likely that economic activity will slow due to supply chain disruptions, decreased travel, and other impacts to the global marketplace.
Regardless of the causes, stock market declines are normal, occur often, and yet are very hard to predict in terms of timing, duration, and severity. The negative momentum displayed by stock markets around the globe currently is common in times of uncertainty. Momentum in stock markets is a well-studied phenomenon and often results in markets over-reacting to both positive and negative news. While this week’s decline in the US stock market has been unusually fast, since 1926, “Double digit losses occur in 65% of calendar years and nearly a quarter of the time losses are greater than 20%”.2
Chart Source: Dimensional Fund Advisors. In US dollars. Data is calculated off rounded daily returns. US Market is the Russell 3000 Index. Largest Intra-Year Gain refers to the largest market increase from trough to peak during the year. Largest Intra-Year Decline refers to the largest market decrease from peak to trough during the year. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Past performance is not a guarantee of future results. Values change frequently and past performance may not be repeated. There is always the risk that an investor may lose money. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Values change frequently and past performance may not be repeated. There is always the risk that an investor may lose money. Even a long-term investment approach cannot guarantee a profit.
Markets are robust and have provided positive returns to investors despite wars, recessions, hyperinflation, and other economic and geo-political events. As many observers have noted, the bull market that began in March of 2009 has been the longest since the end of World War II, as has the period of economic growth without pause for recession. However, bear markets and recessions, though hard to predict, are to be expected. There is reason to be optimistic that markets will continue to reward disciplined, long-term investors.
Chart Source: Dimensional Fund Advisors. Chart end date is 12/31/2019, the last trough to peak return of 31% represents the return through December 2019. Bear markets are defined as downturns of 10% of greater from new index highs. Bull markets are subsequent rises following the bear market trough through the next new market high. The chart shows bear markets and bull markets, the number of months they lasted and the associated cumulative performance for each market period. Results for different time periods could differ from the results shown. Past performance is no guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. Source: S&P data © 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.
What should investors do now?
Investors need only look back to the fourth quarter of 2018, to recall the last time stock markets declined even further than they have so far this month. US stocks came close to bear market territory (a decline of greater than 20%) on Christmas Eve, 2018, only to fully recover and post tremendous gains in 2019. While there is no way to predict when markets will find a bottom and begin climbing again, there is good reason to believe that this time will not be altogether different from previous negative periods. At some point, there will be a change in direction and, just as these recent declines have been sudden and unpredictable, so too, the subsequent recovery may be marked by sudden, sharp upward movement.
For Investors whose portfolios are based on well thought out financial plans and investment policies, it is probable that the best thing to do during this period of market volatility is resist the urge to change anything in the portfolio. For those who find it helpful to revisit their plans and confirm the appropriateness of their portfolio, a conversation with your financial advisor is often very helpful.
In the meantime, wash your hands, cover your cough or sneeze, and follow good health practices!
1. Wall Street Journal Online. Indexes represented are S&P 500 Stock Index, NASDAQ Composite Index, DJIA Dow Jones Industrial Average, 10-Year US Treasury Bond as quoted. AGG:US is the exchange traded fund tracking the Bloomberg Barclays Aggregate Bond Index.
2. https://www.plancorp.com/blog/how-will-the-coronavirus-impact-your-portfolio?
All investment strategies have the potential for profit or loss. Asset allocation and diversification do not ensure or guarantee better performance and cannot eliminate the risk of investment losses.